The Australian Financial System
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3. The Australian Financial System The Australian financial system remains in good expected to persist as banks raise more capital condition, with banks’ resilience to adverse to comply with revised regulatory standards. shocks having increased over recent years. Banks’ The downward pressure on ROE may create an capital ratios are above regulatory minimums incentive for banks to take on additional risk to and those of most international peers (when protect returns. A key element of preventing this measured on a comparable basis). Capital is to ensure that banks retain sound risk culture generation is being supported by high levels of and governance frameworks. The industry has aggregate profit, though there has been little announced a number of initiatives to improve its growth in profit over the past couple of years. risk culture and regulators have increased their Banks’ assets also continue to perform strongly; focus on bank culture and risk governance. the charge for bad and doubtful debts remains Risks within the non-bank financial sector also low and non-performing assets have stabilised appear manageable. General insurers’ profits over the past six months, after increasing a little increased in the second half of 2016, underpinned in the first half of 2016. by an improvement in underwriting results as Overall credit growth has been broadly stable commercial premium rates increased following over the past six months, but the composition of an extended period of underpricing and net this growth has changed, with investor housing claim costs declined. (The cost of Cyclone credit growth increasing. Foreign bank lending Debbie is yet to be fully determined.) In contrast, – which tends to be more cyclical than lending life insurers’ profits fell because of rising claims by local banks – has continued to grow at a rapid that compounded long-standing deficiencies pace, with growth concentrated in infrastructure in pricing, provisioning and claims processes and commercial property loans. This has partly for individual disability income insurance. offset a further reduction in lending by Australian Lenders mortgage insurers also face ongoing banks for higher-density residential development challenges due to declining demand as banks and to the resource-related sector. tighten mortgage lending standards. Nonetheless, The Australian Prudential Regulation Authority insurers in all three segments maintain capital (APRA) will provide more guidance over ratios that are well in excess of their regulatory coming months about what capital standards it minimums and so appear well placed to manage considers are necessary to ensure that Australian these challenges. The shadow banking sector banks are ‘unquestionably strong’. Banks have continues to pose only limited risk to financial also been working to strengthen their resilience stability due to its small share of financial system to liquidity shocks. assets to date and minimal linkages to the regulated sector. Similarly, risks stemming from The increase in banks’ capital over recent years the superannuation sector remain low due to the has lowered their return on equity (ROE). This is limited use of leverage. FINANCIAL STABILITY REVIEW | APRIL 2017 33 Banks’ Domestic Asset Graph 3.1 Banks’ Non-performing Assets Performance Domestic books % % Australian banks’ domestic asset performance Share of all loans Share of loans by type* was little changed over the second half of 2016 4 4 (Graph 3.1). This followed a slight deterioration Business** (35%) in asset performance earlier in 2016, especially 3 3 in Western Australia where economic conditions have been generally weak and housing prices 2 2 Total and rents have declined. Personal (4%) Indicators of banks’ asset performance have 1 1 Housing continued to diverge across the country. Liaison (60%) 0 0 with banks suggests that the performance 2006 2011 2016 2006 2011 2016 of housing loans in mining-exposed regions * Each category’s share of total domestic lending at December 2016 is shown in parentheses; shares may not add up to 100 due to rounding may have stabilised towards the end of 2016. ** Includes lending to financial businesses, bills, debt securities and other non-household loans However, data on securitised housing loans Sources: APRA; RBA suggest that delinquencies edged up further in Western Australia in early 2017 and remained Graph 3.2 Securitised Mortgage Arrears Rates* higher in states with larger exposures to the Balance-weighted share of loans 90+ days in arrears mining sector, where economic conditions have % % been relatively weak (Graph 3.2). The majority WA 0.8 0.8 of banks’ non-performing housing loans remain SA well secured, with the impaired share very low.1 In Qld 0.6 0.6 addition, stress testing conducted by APRA in Tas 2014 indicated that housing prices would have 0.4 0.4 to fall significantly before banks incurred sizeable Vic losses.2 In liaison, banks report that business loan 0.2 0.2 arrears had continued to drift up in the states with NSW large mining sectors, but that the low interest rate 0.0 0.0 environment is supporting asset performance. S D M J S D M J 2016 Future asset performance will continue to * Measured at trust report dates Sources: ABS; RBA be influenced by conditions in real estate markets and the resources sector, as well as basis. Nonetheless, if apartment markets in macroeconomic conditions more generally. The some cities were to turn down and settlement strengthening of housing lending standards difficulties became widespread, banks could over the past couple of years is also expected to incur some losses, particularly on their property support future loan performance on an ongoing development lending.3 1 Impaired loans are those that are not well secured and there are doubts as to whether the full amounts due will be obtained in a timely 3 Previous work has shown that, if apartment conditions were to manner. Past-due loans are at least 90 days in arrears, but well secured. deteriorate in inner-city areas, banks would be more likely to 2 For further details, see Byres W (2014), ‘Seeking Strength in Adversity: experience material losses on their development lending than Lessons from APRA’s 2014 Stress Test on Australia’s Largest Banks’, on their mortgages. For further details, see RBA (Reserve Bank of Speech at the AB+F Randstad Leaders Lecture Series, Sydney, Australia) (2016), ‘Box B: Banks’ Exposures to Inner-city Apartment 7 November. Markets’, Financial Stability Review, October, pp 25–28. 34 RESERVE BANK OF AUSTRALIA Credit Conditions banks have also stopped accepting refinancing applications from new customers on some Overall domestic credit growth has moderated investment property loans and have moved to over the past two months after increasing in late limit negative gearing benefits when assessing 2016, mainly reflecting developments in business serviceability. The most recent round of banks’ credit (Graph 3.3). interest rate rises for investor loans may dampen Graph 3.3 investor demand in coming months. Credit Growth Six-month-ended annualised Credit conditions in the business sector have % % Housing Business been broadly stable over the past six months, although a few lenders have reported 20 20 further tightening in financing conditions for residential development, particularly for Investor 10 10 projects in geographic areas considered at risk Household of deteriorating housing market conditions and Total Owner-occupier localised oversupply. Business credit growth has 0 0 moderated, following strong growth in late 2016 driven by a few large infrastructure privatisation -10 -10 deals. Outside of these deals, the underlying 2007 2012 2017 2007 2012 2017 pace of business credit growth slowed over most Sources: APRA; RBA of 2016, although business credit to small and After falling back following the measures medium enterprises is growing at its fastest pace announced by APRA at end 2014, investor since 2009. Banks have further reduced their housing credit growth has increased noticeably direct exposures to the resources sector. since the previous Review, and is now above Lending by foreign-owned banks operating the rate for owner-occupier housing credit in in Australia has continued to increase, with six-month-ended annualised terms. In liaison, lending by banks headquartered in Asia banks attributed the pick-up in investor credit accounting for almost all of this growth. Asian growth both to strong underlying demand and banks now supply around 11 per cent of the to investors and brokers developing a better stock of business credit in Australia, up from understanding over time of how to comply with around 6 per cent in 2012. Their increased the changes to lending standards introduced lending has been spread across industries, most from late 2014. Of late, the monthly growth rate notably infrastructure and commercial property of investor housing credit has slowed a little, (Graph 3.4). While foreign banks have long been in line with a slight decline in investor loan active in providing such specialised lending, their approvals over the past few months. As noted activity in Australia has historically been highly in the previous chapter, a number of banks have pro-cyclical and has tended to exacerbate asset raised interest rates on investor and interest-only price and economic cycles. (IO) loans over recent months – in part to stay within the 10 per cent investor growth threshold set by APRA – and some banks have further tightened housing lending standards. A few FINANCIAL STABILITY